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Markets: Where Do We Go From Here?
New York: November 04, 2003
By John R. Stephenson

Last week we saw some pretty impressive numbers released by the Fed. According to the most recent statistics, the economy surged to an annualized growth rate (as measured by GDP) of 7.2% in the third quarter. This most impressive of achievements hasn’t been seen for more than twenty years. Add to this the mega-merger of Bank of America and FleetBoston and we have some pretty bullish news. But for some strange reason, equity markets were remarkably well behaved in spite of this impressive news. The S&P 500 did manage a solid gain of 21 points or nearly 2.1% for the week, however, it didn’t seem like the kind of warm reception one would expect for such a great number. The reason? The market is looking beyond the numbers to earnings growth in the upcoming quarters.

The market trades on future expectations for earnings and as such the market had already priced in the strong third quarter economic numbers. With the third quarter earning season winding down and the giddiness that accompanied stronger earnings growth dissipating, can the party continue? To be sure Wall Street had something to cheer about over this last quarter with average revenue increases of 5.6% and operating earnings increasing at 17% for S&P 500 companies, profitability, at least for a while, appeared to be back in fashion. The real question is: can market levels be sustained going forward?

It would seem to be somewhat more difficult to imagine such giddiness in terms of earnings in the upcoming few quarters. For starters, most economists see gross domestic product (GDP) growth in future quarters falling back to the 3 or 3.5% level. A far cry from where it is today. Our own analysis indicates that fully half of the robust 7.2% growth rate was the result of mortgage refinancing and tax cuts. With the economy growing at a more modest clip of between 2 and 3% in future quarters, it seems unlikely that the economy will add a significant number of jobs which will keep a lid on overall economic growth.

Add to the mix a growing and ever enveloping series of scandals in the financial services industry. Most recently, Lawrence Lasser the CEO of Putnam Investments (the country’s 5th largest mutual fund company) was fired for allowing hedge funds to trade in and out of funds in the aftermarket. With New York Attorney General Elliot Spitzer hot on the heels of just about everybody in the financial services industry, it will be a while yet before that important ingredient of trust returns to the market. Absent of trust, look for the individual investor to stuff his savings under the mattress. The institutional investors will continue to scrutinize the numbers and will find them wanting in quarters to come as most of the gains have come as a result of restructuring rather than robust economic activity. With the tax savings spent and with liquidity starting to dry up (see Figure 1) it seems unlikely that the economy can mount a decent encore performance to its third quarter number. Look for markets to head lower in the coming months.

Figure 1: M2- Money Supply

Source: Federal Reserve Bank of St. Louis

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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